Question

Despite the enormous efforts by Modigliani and Miller and the entire time spent by numerous scholars critiquing this theory, the M&M theorem remains unclear and faces many objections.

Can you identify two things about M&M theorem that remains unclear?

Briefly explain.

Answer 1

M&M model assumes that there are perfect capital markets and the markets are perfectly efficient. But these types of markets do not exist in the real world. M&M have argued that it makes zero or no difference to the investors if a firm retains its earnings or declares the earnings as dividends. According to them, retained earnings and external financing balance each other but these assumptions appear to be unrealistic and unpractical although theoretically, it is appealing.

The model assumes that there are no transaction costs in the real world but there is always an expense leading to commission and brokerage to sell shares.